Bitcoin Forum

Please help me understand/explain to an economist friend of mine...

He argues that Bitcoins have no chance in global success because a this system be used to create credit.

Bitcoins cannot be used to leverage. --> You cannot use Bitcoins to create credit.  ---> It can't replace existing credit already created by the current system.

For Bitcoins to be successful, it has to be able to replace the existing debt!

Please help me:

Where is he right/wrong?

It is possible to fractionally reserve Bitcoins, but what is not possible is printing new currency at will to cover unbacked credit.

This means the institutions which currently benefit from the ability to issue unbacked currency/credit will probably never adopt Bitcoin. How much longer those instutions will continue to survive is an open question.

If "success" is defined by the ability to repay all the debt that currently exists in the world, as well as make good on the unfunded obligations which government have promised to their citizens then no monetary system will be successful. The unpayable debts will be defaulted, either outright via repudiation and/or dissolution of governments, or via inflation. The consequences of these defaults are not avoidable but Bitcoin represents a way to prevent the situation from happening again.

Ehh, firstly, it's the easiest thing in the world to create bitcoin-denominated credit. This is being done all the time on this forum. Of course because of the limited nature of the resource, no sane person wants to owe anyone huge amounts of bitcoins.

Bitcoin is not even supposed to replace inflationary currencies, but complement them. It is not clear if bitcoin can ever be technically scaled up enough to be the sole exchange medium in the world. On the other hand, sovereign nations need to be able to issue their own inflationary currencies through their central banks just to continue functioning, at least in the current environment.

I could see Bitcoin eventually replacing some "specialty" pseudocurrencies, like the SDR, if it really takes off. It won't ever replace fiat.

Bitcoin can be lent, but cannot create credit in the way that fiat currencies can.  Currently, large economies are making up (creating from thin air) huge amounts of currency to buy debt and other assets, manipulating the economy.  This is not possible with BTC which is one of the major advantages of it.  However, this is not the way the economy currently works.  BTC will give users a guarentee that it will not be devalued by a central bank printing more BTC, BUT it does make it less flexible for those central banks and will therefore never be adopted by them.  This is a currency of the people for the poeple!

One of the reasons why Bitcoin is so brilliant is that FRB (Fractional Reserve Banking) is actually much more difficult than with any other monetary system. Even with gold it's very much possible even though the base money (gold) can't be expanded. In a fiat money system even the base money can be expanded forever and ever, which is exactly what the central banks do.

With Bitcoin there is a radical difference. The base money is essentially as fixed as gold but the big difference is that it's independent of centralized institutions. With Bitcoin there is a very limited need or advantage to deposit your money anywhere. This is why a large portion of Bitcoin transactions will always move outside the banks and this will make it impossible to practise fractional reserve lending in any major capacity.

It will of course be possible and even likely, but instead of banks having 10% reserves, Bitcoin banks will have much larger reserves. This is of course a VERY GOOD thing, don't let anyone tell you otherwise. Tell that "economist" to read something else for a change. Recommend Schlichter's "Paper Money Collapse".

You can't beat years of brainwashing imho.

You can always tell him that loans in bitcoin are doing fine (I lend 100 btc just a few days ago), but that you can't replace the existing system of debt out of nothing for the benefit of the 1%, which is precisely one of the strong point of Bitcoin :)

I bought 25 bitcoins the other day. I took ~$250 in debt-saddled currency and converted it into 25 units of debt-free currency.

Bitcoin can't do much for the mess that economists and bankers have made of Federal Reserve instruments and their derivatives, but it can go a long way to helping to create a later economy less encumbered by debt-based currency.

Debt is never money, no matter how much kooaid Central Bankers want us to drink.

His is, indeed, a very conservative pro-establishment Keynesian point of view.

If you are looking for arguments, look into the discussion for/against (a return to) the gold standard. The points will be almost identical, but there will be a lot more info.

One of the things he's wrong in is propounding the legitimacy of fractional reserve banking.

He's wrong because I can owe you 100 bitcoins without having 100 bitcoins. Heck, I can owe you 25 million bitcoins even though 25 million bitcoins will never be in existence at the same time.

For Bitcoins to be successful, it has to be able to replace the existing debt!

Whos debt? This reveals a thinking stuck in old system.

Should it replace, US debt? The Zimbabwe debt? whole worlds debt?
All money in the world, including chinese Yen or just the dollar?

Short answer is ofcourse: No.

There is really allready countries which has dual currency systems which works absolutely perfect.
In fact a dual currency system often works better.

Bernard Lietaer: Money diversity
http://www.youtube.com/watch?v=T9EI2PrDpmw&feature=related

It does not have to replace anything to be useful.
A glass can exist and be useful without having to replace all the old glasses.

I can get BTC10 that was not created out of debt, by selling something for them, doing some work, mining them, trading them
for debt based money.

I can trade a sock for 0.1Btc if I want. Without caring how many dollars a Bitcoin is worth.

When I have those. No need to use debt based money anymore.
(Except to pay taxes.)

Its not hard.

And Bitcoin does not belong to a single country.
Its independent.

Throughout the course of history, humans have always moved to better forms of currency.

Beads -> Sea shells -> Wampum -> Metal Coins -> Gold -> Paper money fiat -> Electronic money (paypal, credit cards) -> Return to gold? Bitcoin?

Paper money fiat is better than gold? Huh?

Just tell him bitcoin is as much a commodity as a currency then tell him to learn about 'Austrian' economics.   

he seems to think debt equals money and money equals debt. money arose from barter, not debt

False.  Money arose from debt, not barter, thousands of years ago.  But not in the way most people think.

In case someone still thinks otherwise, I'll repeat: It's possible to have fractional reserve banking, credit expansion etc. in Bitcoin. Of course there will never be more than 21 million BTC out there, but there might be a much larger amount of "bitcoin-backed" credit around without trouble. As long as there's enough reserve and there isn't a run on the bank, it will work. Of course it won't make much sense now, but in far future it might.

+1

Fractional reserve lending wouldn't work well with BTC; the banks practising it would quickly fall to bank runs.  See also Rothbard for a discussion of this.

I don't agree. Bank runs caused by liquidity issues are a solved problem. Bank runs caused by insufficient equity (say due to bad loans) cannot be solved.

All you do is increase the interest rate if a liquidity crisis makes you unable to meet payment demands. Since you have the equity, your debts will be worth at least face value (because the interest rate is above market rate and you have the equity to pay). So your customers who don't want to wait can just sell the for more than they could withdraw for. You take a loss due to the above market interest you have to pay, but you don't harm your customers. (Of course, they have to know and agree to this up front.)

This doesn't help, of course, if you don't have the equity to back your debt. So it solves the problem of everyone withdrawing at once. But it doesn't solve the problem of too many of your loans going bad. (Like the mortgage crisis.)

What would you rather accept? A Bitcoin backed credit or a real Bitcoin...
Its possible, but with Bitcoin, what you see in your Bitcoin adress belongs to you, and you can look up that the coin is really there in blockexplorer etc. Its not just like some numbers in a bank account.

With Bitcoin, a bank run would look like an attempt to withdraw larger amounts of Bitcoins quickly, rather than queues forming in front of the banks. If there was a problem with withdrawals, people would start complaining in the forum, the news would pick it up and it could escalate very quickly. Even now when the amounts are, on global scale, negligible, it does not even take 24 hours for the word to spread.

The issue of liquidity is not solved at all. FRB works because banks issue short-maturity (even zero maturity) instruments, but the maturity of the loans they issue is higher (can be years). They carry the risk for this difference. If they were forced to liquidate the loans prematurely, they would need to take a cut, and this would result in undercapitalisation. Furthermore, as Taleb for example convincingly argues in The Black Swan, a lot of risk is not correctly modeled.

This is a smaller problem if FRB is merely a method of bringing together investors and creditors. People normally do not expect to withdraw their deposits immediately. If however those instruments are also used as a medium of exchange, people do expect to be able to use them for payment right away, and if this does not work, it has a direct impact on their business or lifestyle, and aggravates the panic. People can't pay rent, food, their suppliers or employees. That's an immediate problem.

I would say that most people depositing into traditional banks do not think of themselves as investors, or at least they don't think of their checking account as an investment.

There is a duration mismatch problem that is fundamental.  If a bank loans out money for a 30 year mortgage, but people want their money back sooner, the bank is screwed.  The bank is "good for it", but can't pay out today.  The modern solution is for a central bank to be able to create money out of thin air and lend it to the bank.

Since a bitcoin bank can't create money out of thin air, it always faces the possibility of a run.  Bitcoin banks could band together with an agreement to loan each other bitcoins as needed, and this would mitigate the problem during isolated or limited bank runs, but if everyone everywhere gets spooked at the same time, the game is up.

The solution is to be clear on both sides about repayment timelines.  The bank could not use demand deposits for duration loans, and the customers could not ask for early withdrawals on duration deposits.  Clever banks would attempt to mitigate this by creating markets for duration deposits, giving people an option to cash out early by selling the certificate to someone else at a discount (penalty), but it would need to be clearly understood on both sides that this system is not a promise of liquidity, but a last resort.

How do you see that happening, how do you see Bitcoin forcing all the debt that is currently in the system to get defaulted?

The idea that Bitcoin will force the "repudiation and/or dissolution of governments" is a far-fetched notion.  They still have the ability to "make laws" at will, and to their own preservation. 

I and my friend agree... but what does that mean for it's growth potential?  So (he asks) why even have a new currency, if Bitcoin was supposed to get rid of the current hyper-inflationary system.  It is not really fulfilling its purpose, it is just staying there.  Right?

Bitcoin can be used to create credit as long as two parties agree on terms with Bitcoin amount as notional.

Fair point.  :)  But for Bitcoin to be successful, it should be widely accepted.  The point being contested is whether the gov'ts would even allow Bitcoin to grow given they control the nations' laws and armies.  Just like bitTorrent exists but cannot/have not eliminated copyrights.

Unfortunately, no.  Just like the gold standard, a paper money system was created with gold as backing, and as gold backing was made redundant at a point.  It's equally plausible to create a paper system with 25 million bitcoins and get rid of Bitcoin backing at some point.  But the question here is whether Bitcoin can get to that stage. (?) 

This is pretty much the case in point, it is what my friend is trying to say!

As the "paper system" would not decrease transaction costs, it would not be accepted by market participants as a substitute for native Bitcoin. Acceptance is a prerequisite for both credit expansion, and a removal of backing ("fiatisation" of commodities). This is a critical difference between gold and Bitcoin.

If the existing debt is not replaced, it must be written-off. This act will set a precedent to the creation of more debt.


In case of dual currency systems both currencies are still taxed, and they are within the control of a single gov't.  Given that Bitcoin is a "perfect" way to evade taxes, it's growth is likely to be curbed by unwilling governments.  In his opinion it makes it very difficult to co-exist as a major currency.

An ePaper system can be created, which would decrease transaction costs as well.  

Even in the current day economy the instrument that most investment banks create don't have more than 2 parties entering the transaction as long as the two parties are comfortable taking on the credit risk.  However the two parties being large financial institutions, they allow the credit risk to cascade further into the economy.  Bitcoin is not immune to this effect.  

This is me talking (C.H.)... and I have to point you to Gresham's Law:

http://en.wikipedia.org/wiki/Gresham's_law

"When a government compulsorily overvalues one type of money and undervalues another, the undervalued money will leave the country or disappear from circulation into hoards, while the overvalued money will flood into circulation."

so, if Bitcoin's are "good money" there maybe a totally opposite effect to the "expected" ... humans are just so puny and inferior to their "own" Government's! :( 

I truly hope Bitcoin's insurgence will be one time when Gresham is proven wrong! :)

Why does it need to replace the current debt system in order to be be a success?  They can run in parallell.  You dont have to have one or the other!  I think that the adption of bitcoin is a better measure of its success rather than the demise of the current system.

I consider bitcoin to be a monetary superset of gold, since it has gold's properties (but better) plus convenient electronic transactability... So, it has two ways to become valuable: by servicing the store-of-value market-needs that gold currently covers, and/or via its transactional properties. It doesn't have to replace an existing major currency to be successful (valuable) long-term. Discussed more here: https://bitcointalk.org/index.php?topic=100065.0

With something like Bitcoin, this is very difficult to pull off. Bitcoin is form-invariant, i.e. can exist in almost any form. Any medium able to store 64 bytes of data can act as a native Bitcoin form. Furthermore, the acceptance of a credit instrument is burdened with counterparty risk and, for banks, the issuance is accompanied by the costs of maintaining reserves, and these need to be shifted over to the users. Neither of these exist when using specie, and they constitute a hurdle that a credit instrument needs to overcome to decrease transaction costs over specie.

There is a difference between credit and circulation credit, i.e. credit instruments that circulate as media of exchange. The latter, by definition, involves a counterparty risk.

i little bit of offtopic but it would be interesting to see the arise of the ones who adopted Bitcoin fully, but in the same time rejected every other monetary system. we just need the critical mass of them, for dollars and similar trash to really become useless... that would be "a complete success of Bitcoin", but the starter of the topic (his friend "economist") implies that ones who are heavily dependent on the system as it is right now, should somehow stay wealthy and continue to enjoy their parasite lives instead of being completely broke as they should become, after the full adoption of a Bitcoin.

Gresham's law only applies to exchange rates as dictated by law. Bitcoin is a whole new beast as it's rates are beyond what the law can decree, so Gresham's law doesn't apply in this case.

After we see what happens with Bitcoin, perhaps we can formulate Satoshi's Law.  :)

It can only attain a tiny tiny fraction of current systems unless it is solidly better. Once it is widely accepted and solidly better it's just going to crush. The USD etc are not things that can partly crash. If ~half of the value rushes out of them and into bitcoin the rest will follow.

edit: maybe I didn't read carefully, I was just thinking "current system" and nothing about debt in particular. Debts are going to be denominated in whatever currency people use because that's the only convenient way to do it.

Define "solidly better".

My only concern so far with bitcoin is the lack of, or inability to, prosecute fraud and uphold contracts. That's what makes lending difficult in my opinion. Also, we could have institutions that practice fractional reserve banking, but it is not backed or guaranteed (FDIC). This means that customers (lenders) of the bank are at much more risk because of the high percentage of the reserves (customers money) being lent out. This makes their savings illiquid and risky. So in order to do this, the institutions would have to offer high interest rates and not be able to guarantee instant liquidation at moment's notice. 

This is a good point but I would not be worried because there are ways to fix this, my concern is wider growth or diversity usage of the currency.  The value of the currency is great but if the use could be diversified then I think stability would grow allowing for greater growth.  Guarantees will follow and there are ways to develop them but that will probably not happen until greater utility. 

Just my thoughts on the subject but I would like to see more guarantees offered too.

A contact in Bitcoins is no different than a contract for bandwidth or gold or manure.  Most "contracts" in Bitcoin land haven't been enforced because:
a) they aren't contracts.
b) they are unlawful (i.e. Pirate's savings plan was usurious in every state of the United States).
c) they involve thieves.

Put a,b,c in a "deal" involving dollars and you will be equally broke.

We need a real bank, but who certifies it? Do we need to certify it? Security is a huge issue as the hacked exchanges have shown. We can't have safe lending until there is liability.

It's a little early to draw a conclusion about the right/wrong part, but I would suggest asking him how would he define success? what would he accept as criteria that must be met for bitcoin to be considered successful?

I'm curious as to his response.

GO SATOSHI's LAW!!!

But old system thinking gave you the internet and the computer you wrote your post with.

TCP/IP is new system thinking - open-source and non-proprietary. It's becoming the norm with those that grew up with it.

...like roads..  ::)

Why does anyone need to borrow Bitcoin?
There is not much of an economy yet, the bulk of the economy is supported by selling drugs. 

If you have good credit borrows from the bank, and buy Bitcoin's.

If you are lending in this environment you have questionable money management skills.
If you borrowing BTC in this environment you are most likely a doing something any legitimate bank would not condone. 

When I made my fist Bitcoin purchase I didn't want to spend my hard earned Bitcoin's so I bought some and used those.  This was the type of action that grows the economy; however I only used Bitcoin because I am an enthusiast.

If the Bitcoin economy were bigger I may be compelled to just buy in. However buying Bitcoin to partake in Bitcoin economy will create a demand for Bitcoin. When you look at the "innovation adoption curve" (http://en.wikipedia.org/wiki/Diffusion_of_innovations) that demand will be filled by the innovators who have lots of BTC to sell. The people who build the economy are the Early Adopters paying the price and the benefactors are the Innovators. (the Early Adopters are key to the successful adoption of Bitcoin for mass market appeal )

In my view you need the Early Adopters to adopt Bitcoin and build the economy in order for it to propagate.  For that to happen the Early Adopters need a motivation to build the Bitcoin economy.  I see wild swings in boom and bust cycles as the ideal stimulant.  Boom bust to me is like gambling only you can cashing out without loss if you have a stable supply of BTC, it also creates risk for the hoarders, once one is in the economy one eventually establishes a legitimate way to obtain BTC and cash out during the swing, thus the economy slowly builds, and the Early Adopters benefit. ( That is, what I am doing now except I am trickle mining, as opposed to building the economy. So technically Miners fall in the Innovation stage, and Silk Road would fall in the Early Adopter stage)   

Without a transferring of Innovators benefits to the Early adopters benefit,  the Fiat to BTC rate will crash. When it crashes the early adopters benefit, and as the Bitcoin economy grows again the innovators benefit disproportionately to the work done by the early adopters and the system crashes again, and this will go on and on until the wealth of the innovators is eroded.

Just like the sun will rise and fall every day and we will have seasons, the system will optimise over time a decade at the least but it is going to be a rough ride and there will be no guarantees, there is a higher probability of a stalemate along the way, but just to be safe you should mine your [btc20] anyway. 

There is no point in knowing if it will succeed before it succeeds, if you knew that, you could cheat the system, if you could cheat the system it would fail.

These debates are fundamentally about risk taking.  What will cause Bitcoin to fail is the horders unequivocal faith that the system will prevail, and the Early Adopters (labour that builds the economy) choosing life as usual. IE. a stalemate.

This stalemate could be the end of cripocurancy or its collapse, and with all natural systems collapse there is fertile ground for rebirth.   

Bingo... JoelKatz scores again.

Bitcoins credit can exist just fine. I've made loans, and received loans, both with interest, and both paid back. Guess what... it worked! 

But why on earth would anyone borrow Bitcoins at present when you can get a Fiat loan for interest that's lower than inflation?

A Bitcoin loan otoh carries a significant risk of Bitcoin gaining significant value and a default as a consequence.

At some point, when bitcoin is more mainstream, this will change, of course.

Prissily, not a good idea to borrow Bitcoin's at the moment, unless you can sucker someone into lending them and default.
But I think the point was you can lend and borrow any amount it is not limited by the total supply. (and it has been tested despite the risk)   

Sorry if cross-posting this here is obnoxious, but it seems relevant and I'd be interested to hear people's reactions. Thanks!

Seems a waste of time to empirically test the obvious. The question is only: Is Bitcoin the cheapest way to borrow money. At present, the answer is NO. A few years down the road, when Bitcoin is in the 4-digits and value increase is in the single digits - and inflation in the FIAT world is deep in the 2-digits, the situation will change because nobody will give you a FIAT loan if inflation can at any time get into the 3-digits or higher unless you pay outrageous interest.